Sustainability is an increasingly important criterion in consumers’ spending choices. They buy clothing made of organic cotton, avoid unnecessary air travel, and spurn products containing palm oil. But sustainability plays a much smaller role in their investment decisions. This disparity is beginning to change, albeit slowly. In 2019, for example, retail investors in Germany put almost twice as much money into sustainable financial products as in 2018. Despite this growth spurt, sustainable investment remains a niche market: it accounts for just over 5% of the country’s total fund investments. A study from 2019 attributes this to three main factors. People fear losing money, their financial advisor doesn’t propose sustainable investments, and they don’t feel well informed. The purpose of this article is to provide some of this information.
Myth #1: "The returns on sustainable investments are lower.”
Actually, MSCI World Socially Responsible Investment Index has outperformed the broader MSCI World Index for several years. Similarly, in early 2020 Scope Analysis, the research unit of Germany-based Scope rating agency, released a study showing that in the previous ten years the annual returns of sustainable equity funds averaged roughly half a percentage point higher than those of standard funds. Counterintuitive? Not really. With climate change becoming an increasingly prominent social and political issue, it’s hardly surprising that, over time, sustainable stocks outperform their less sustainable peers. After all, these are the companies that will benefit most from changes in policy priorities and in consumer behavior. Once word gets out to fund managers and retail investors, the trend will likely gain momentum: as more capital flows toward sustainable stocks, their prices will rise.
Myth #2: “There are hardly any sustainable financial products to choose from.”
This is no longer true either. In fact, there’s a wide range of green investment options, from individual stocks and ETFs to microfinance funds and green bonds. According to Scope Analysis, Germany alone has 145 sustainably managed investment funds. Green bank accounts are now available as well. Tomorrow Bank, a Hamburg-based startup, pledges that it will invest in “sustainable and social projects” only and is guided by the United Nations’ Sustainable Development Goals.
Myth #3: “It’s hard to accurately assess a financial product’s sustainability.”
Admittedly, there’s some truth to this. Sustainability means something different to everyone, including in the financial sector. Investors’ first step is therefore to define what sustainability means to them. The second is to assess whether a financial product meets this definition. For their part, the managers of sustainable investment funds generally adopt one (or a mix) of four strategies:
invest in industries that specifically pursue sustainability, such as renewable energy (although this limits opportunities for diversification and thus poses a financial risk if an entire industry experiences a slump)
avoid problematic industries like arms manufacture, tobacco, and those industries known to use child labor
adopt a best-in-class approach and invest only in the most sustainable companies in each industry (even in problematic industries this rewards those companies doing their best to be less harmful)
use shareholder voting rights to promote sustainable thinking.
As for bonds, the EU intends to set binding standards for green bonds and thus give sustainability a universally valid definition. The standard could be adopted as early as 2021.
Myth #4: “My investments don’t tangibly impact the environment.”
Obviously, small investments have a smaller impact than big investments. Nevertheless, the right investment can help reduce carbon emissions significantly (some funds provide detailed information about their portfolio’s carbon intensity). The Potsdam Institute for Climate Impact Research, for example, is optimistic. It believes that the trend toward more sustainable investment could have a domino effect across the entire economy. Dr. Jonathan Donges, a researcher at the institute, suspects that the tipping point will come when climate-neutral power generation delivers higher financial returns than fossil-fueled power generation.
Myth #5: “My inaction harms no one.”
Perhaps hardly anyone expresses this thought aloud. Secretly, however, many people assuage their conscience with the notion that the money in their bank account may not save the world, but at least doesn’t do any harm. This isn’t necessarily true. Banks loan money to companies that manufacture weapons, engage in child labor, and cut down rainforests. In some cases, unfortunately, saving accounts are funding these activities.